Hey Hollywood: Netflix Isn’t the Enemy; Old Thinking Is

For an industry good at making big pictures, Hollywood is pretty lousy at seeing the big picture. Thursday, Reuters ran a story quoting several anonymous sources in the content industry that portray Netflix as a shark, out to steal their content — and the television and movie industry’s revenue. Unfortunately for Hollywood, Netflix isn’t the real enemy; broadband and the digitization of content is.

The studios and networks helped create this monster by selling Netflix streaming rights to their content, and now they’re finding they can’t control it. The feeling from content owners — that Netflix is going to eat their lunch if they aren’t careful — has got many rethinking their dealings with the company, and how they distribute digital content in general. Instead of blaming Netflix, movie moguls need to figure out how to make money as their industry moves online, just as moguls in the music and media industry are trying to do today with varying levels of success.

Netflix isn’t being a bad actor in all of this. It’s playing by the rules, writing checks and compensating content owners for the video streams it serves. In fact, the company has even made some concessions along the way, agreeing to a 28-day window for distribution of DVD releases and a 90-day window between when new movies are available to Epix pay TV subscribers and when Netflix users can stream them.

In some cases, however, it’s paying much less than one might expect for the content that it serves. For example, its deal with Starz Entertainment gives it access to films from Disney and Warner Bros. at a fraction of the price that cable providers pay for the network. The Starz deal is valued at around $20 million to $30 million, according to some estimates. Considering Netflix now has about 17 million users, it pays less than 15 cents per subscriber, compared to the $2 dollars per sub that cable companies typically pay for the premium cable network.

Of course, when Netflix struck that deal back in 2008, no one knew that it would grow into the streaming powerhouse it is today. Back then, Netflix had about half as many subscribers as it does today, and only a fraction of those users took advantage of its streaming service, which was relatively new at the time. The deal expires this year, but Netflix seems confident it will be able to re-up with Starz when the deal comes up for renewal.

On a recent earnings call, Reed Hastings said he was confident of a Starz renewal, saying, “We have money to pay and they are in the business of collecting money.” That’s really Netflix’s value proposition to the content industry: it spent $1.2 billion on securing streaming rights this year, and could nearly double that to $2 billion in 2011. But $2 billion isn’t much when compared to the revenue that broadcasters get from TV advertising or carriage fees from cable companies, and it won’t make up for the loss of revenue Hollywood studios are seeing from declining DVD sales.

At the same time, Netflix is only a symptom of a broader paradigm shift, one that the content owners are still learning to navigate. The transition from analog and physical distribution of media to digital distribution has rocked the music, newspaper and publishing industries, and now it’s got the TV and movie industries in its cross-hairs. Unfortunately, the broader video industry is poised to make the same mistakes that its forbears made, by shutting out new business models rather than embracing them. A few weeks ago, Om wrote:

“When I look at these industries and the failure — or impending failure — of these institutions, I see a fundamental mistake on their part to understand their own core businesses. They fail to see the world in a larger context, and instead, choose to focus on maintaining the status quo.”

And this gets to the heart of where the studios have got it all wrong with Netflix: They’re unhappy that their content is practically being given away for a subscription of $7.99 a month, and that consumers are getting a better deal than if they paid for cable or bought a DVD. But for all their worries about the destructive tendencies of Netflix’s business model, they can’t rely on the old way of thinking if they plan to survive the digitization of the video marketplace.

Transitions like this one are never pretty, and we’ll likely see some major pain as the studios try to negotiate this new territory. But if the content owners want to survive, they’re going to have to be forward-thinking in their approach to making their content available online. Refusing to work with digital distributors like Netflix isn’t a solution, but part of the problem.